Inflation drops below Bank's target for first time since 2007

Sharpest monthly fall in cost of living since modern records began in 1948
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The Independent Online

The economy edged closer to deflation last month as the retail prices index (RPI) registered a record 1.6 per cent annual fall – the steepest drop in the cost of living since modern records began in 1948, and probably since the early 1930s.

The consumer prices index (CPI), the internationally comparable measure that strips out the lower mortgage interest costs that have left the RPI in unsheltered territory, also fell. It declined from 2.2 per cent in the year to May to 1.8 per cent, pushing it below the Government's 2 per cent target for the first time in almost two years.

Much of the reduction in inflation, on both measures, was due to a dramatic easing in the rate of food price inflation, the Office for National Statistics said. At this time last year the cost of food was soaring by almost 15 per cent per annum; it is now down to 5.4 per cent, and food prices actually fell by 0.2 per cent between May and June.

The depressed state of the economy, particularly the housing market, has left many household goods and furniture retailers with little room to raise the prices of their stock. Smaller increases in the cost of petrol and diesel than were seen last year, a consequence of the steep drop in the price of crude oil, has also helped inflation towards its record lows.

Economists were divided on whether the new figures, which were in line with City expectations, heralded a sustained period of falling prices and deflation, or whether the underlying upward pressure on prices from a weaker pound, the Bank of England's injection of £125bn into the economy by next month and, eventually, rising interest rates and VAT will propel inflation back up again.

The "core" inflation rate, which excludes highly volatile items such as food and fuel and gives an idea of what is happening to the fundamentals in the economy, remained flat in June, at 1.6 per cent. UK inflation remains much higher than that in the US, which is now negative at -1.3 per cent, and the eurozone, at -0.1 per cent.

The latest definitive data on house prices also suggest that the risks of a widespread, classic deflationary episode, with asset prices collapsing, may be exaggerated. The Department for Communities and Local Government said the fall in house prices narrowed to 12.5 per cent in the year to May, from 13 per cent in April and a peak of 13.6 per cent in March. Property values fell by a mere 0.1 per cent from April to May, suggesting some flattening in the rate of decline, though the monthly returns are volatile.

Still, the drop in retail inflation relives pressure on the Bank of England to end or even reverse its policy on quantitative easing, as some have urged. Yesterday, the newest member of the Bank's Monetary Policy Committee, Adam Posen, said "much too much has been made of this so-called pause", referring to last week's silence on whether the Bank would take up the last £25bn of its current allocation of £150bn.

Asked by the Commons Treasury select committee about the Bank's "exit strategy", Mr Posen said: "I would hope to be doing it immediately because that would imply the crisis is over, but there is not a chance in hell of that happening." Following similarly "dovish" remarks this week by the Deputy Governor Charles Bean, who said "we don't want to do it too early and nip the recovery in the bud", Mr Posen stressed that "the risks right now certainly are more about deflation than inflation in the short-term". He added: "What Japan has demonstrated is that once you fall into a really deflationary situation, it's very hard to get out. It's very sticky".

Unemployment data today is likely to show another rise, with dole queues lengthening by about 40,000. Even if the economy improves as rapidly as the most optimistic forecasts, the jobless total seems set to move inexorably towards 3 million next year.